Finance Minister Nirmala Sitharaman’s giant tax cut will lead to corporate profits rising by 30 percent. The stock markets celebrated this profit boost with a six percent rise which is the single day biggest point gain in the history of Dalal Street. On the other hand bond markets have seen probably their biggest fall in recent times, indicating that the fiscal stimulus comes at a cost, the cost of higher yields. Is this a big price to pay? Not necessarily. The government can aggressively disinvest given the higher share prices and thus reduce the now higher fiscal deficit. The Reserve Bank of India (RBI) can buy more government bonds and smother interest rates in the economy. Given the general weak deflationary situation in India and the world, such a monetisation of the deficit may not lead to any ugly rise in prices.
But the larger question one needs to ask is: Will this corporate bonanza lead to a jump in economic growth, i.e. in GDP? Will people other than just corporate shareholders and captains of industry benefit from the tax cuts?
The simple answer to this question is “no”. The tax cuts need not lead to more jobs and salaries for the broad mass of Indians. In that sense, this cut increases inequality by rewarding the rich – the owners of companies, and doing nothing directly for the consumer, the employees of companies and individual tax payers. A more egalitarian cut would have been a cut in personal income tax. At least two percent of India pays income tax. Even more egalitarian would have been a sharp cut in GST because all Indians would have gained from cheaper biscuits to phones to haircuts to cars.
However, the corporate tax cut has some advantages over income tax and indirect tax cuts in terms of a growth push. Any cut in income tax could have boosted purchasing power of just about two percent Indians and a GST cut would in the first place be difficult because a majority of the states would have to be convinced. Of course both together could have lent a push to more capex by corporate India to cater to the higher demand.
Clearly, the government has chosen to boost growth via the investment route rather than the consumption route. These tax cuts are permanent and in that sense represent a structural change in the economy. It represents a seminal change in the investment climate since it raises the return on equity and may be even the return on investment. By bringing down the taxes, India’s rates are now comparable or even lower than countries competing for investment such as China, Vietnam and Philippines. There is a very good chance that large investors from USA such as Apple Inc can choose India as a major manufacturing hub. Companies contemplating moving out of China may also consider India an attractive option given the competitive tax rates. This in turn can create jobs and demand and speed up the slowing economic growth cycle.
Vibrant Indian companies making products of daily use such as soaps and shampoos, boots and beer, paints and tiles are already doing well and they may well look at the option of more investment. Indian service start-ups and foreign back offices can also invest with more gusto and all these together can help growth pick speed. Companies who are suddenly making profits hand-over-fist can reduce product prices to capture a larger market. This can boost demand and hence investments to meet that demand. Fear of job losses can recede when companies make profits and this can result in more loan-driven consumption.
Thus the vicious cycle of lower income leading to lower consumption, lower savings and hence lower growth can be broken. And yet all these need not happen. As Viktor Shvets of Macquarie wrote, “The problem with this (Indian) cut as well as the widely discussed Indonesia’s move is that while corporate tax cuts do enhance equity valuations and support asset prices, there is no evidence that they actually meaningfully spur investment or employment. This was the case with the USA tax cuts as indeed it was true with every single other tax cut move globally. There are other factors that turn tax cuts into viable stimuli, such as deep structural reforms, flexibility of labour markets, elimination of trade barriers etc. Alas, India still remains one of the world’s most difficult places to do business.”Shvets has summed up the problem well. After making a bold start with giant tax cuts the government needs to maintain the tempo by quickly introducing a genuine change in ease-of-doing business by introducing labour reforms and cutting the red tape that genuinely eases doing business in India. The government has made a great start. But the search for economic growth is a marathon race and not a 200 metre sprint. A little noticed change is that expenses which count under corporate social responsibility have been increased to include investment in IITs and research institutes. More such creative steps can usher in lasting growth. Is the tax cut a structural reset? It can certainly be the start of such a reset.